If you have had a home for quite some time, you know it is not just a piece of the American dream. It can also be the most valuable asset you have — an asset that you can use when you need to borrow money, either through a mortgage equity loan or through a home equity credit line (HELOC). Here’s what you need to know about applying for one.
- Both mortgages and home equity credit limits are based on the difference between the current value of your home and the amount you still owe on your mortgage.
- Mortgage lending tends to have lower interest rates than other lending options because they are secured by your home and are considered less risky for lenders.
- A home equity credit line works like a credit card, as you have a fixed credit line with which you can borrow when needed and then repay over time.
Housing equity loans against HELOC
When it comes to borrowing money, both a home equity loan and a HELOC are secured by probably the most important piece of collateral you can offer – your home. If you have equity in your home, which is the difference between the amount you currently owe on your home loan and the current market value of your home, you can use either a home equity loan or HELOC for a portion of that equity capital. Here’s how the two differ:
What is a home equity loan?
Mortgage equity loans work just like any other type of loan. When approved by a lender, the borrower receives the entire loan as a single lump sum. The borrower can spend the money as he deems appropriate, such as for debt consolidation, payment of emergency bills or a home renovation project. The borrower then has to repay the loan through a series of scheduled payments. The duration of a mortgage loan can last from 5 to 30 years.
Mortgage equity loans have a fixed interest rate. This interest rate will usually be lower than what the borrower could take on other types of loans because using the home as collateral makes the loan a safer bet for the lender.
Mortgage equity loans are usually referred to as second mortgages or equity loans.
What is a Equity Credit Line (HELOC)?
If equity loans work like traditional loans, then a home equity credit line works similar to a secured credit card, except that instead of using the money in the bank as collateral, the borrower’s home works.
Once approved, the borrower is able to receive money through a recyclable credit line. Therefore, the homeowner can borrow part of his current credit line, spend the funds, repay those funds with interest, and then get more money later. This allows the homeowner to access cash when they need it and not all at once. This can be useful, for example, if you plan to renovate your kitchen this year and add a deck in a year or two.
Unlike a mortgage, but similar to most credit cards, HELOCs have a variable interest rate. The interest rate will fluctuate over time based on market forces, the borrower’s credit score and the amount borrowed at any given time. This results in a minimum payment that can be increased or decreased between scheduled payments, making HELOCs less predictable for the borrower than home equity loans.
Requirements for applying for a home equity loan or HELOC
If you know exactly how much you need to borrow and you know that you can repay this amount in many years, then a home equity loan is probably the right choice for you. However, if you are not sure how much you will really need to borrow or for how long you will need to keep making money, then you should consider a HELOC.
Once you’ve got that determination and want to move on, there are some things you need to keep in mind before you are approved by a lender. Usually, both options have similar requirements, although each lender is different and may require something that their competitors do not. Laws may also vary from state to state. These are just some of the goal setting shareware that you can use.
- You will need a lot of equity. First, of course, you need to have equity to borrow. Keep in mind that lenders will not let you borrow your entire amount of equity, but will generally limit you to no more than 85% of it. So if you have raised $ 50,000 in equity, you may be able to borrow up to $ 42,500 if you meet all the other requirements. Also note that mortgages and credit lines usually cost thousands of dollars to close, so you will leave with less than the amount you have borrowed.
- You will need a good credit score. Prospective lenders will also expect you to have one fixed credit score, which they use as an indicator of how risky lending to you is. Although lenders differ, most will want to see a credit score in the mid-600s or so before they even consider your application. Obviously, the higher your credit score, the better. (The highest possible credit score is 850, but anything above 670 is considered good.) The lender will also check your credit report for additional information about your creditworthiness, including the types of credit you have, how much you owe, how long. accounts have been opened and if you have late payments in your file.
- You can not have many other debts. The lender will also look at the debt-to-income ratio (DTI), which measures how much of your monthly income is already going into other outstanding debts. You will probably need to provide proof of income in the form of receipts, W-2 forms or other relevant documents. In most cases, lenders will want to see a DTI of no higher than 36%, although some may reach 43%. All your monthly loan expenses, including your current mortgage payment, any student loan debt, credit card bills and other debts are added up and then divided by your monthly income to reach that number.
The bottom line
If you have equity in your home, a home equity loan or HELOC can be an easy way to use some of that equity for other purposes. What will work best for you depends on whether you need to borrow a fixed amount now or you would prefer a more flexible line of credit that you can use as needed.
Keep in mind, of course, that either a mortgage or HELOC will put you in deeper debt, which can be a problem if you are facing a severe financial upheaval due to job loss, large medical bills or other unforeseen events. And because these loans are secured by your home, you could lose them if you are not able to keep up with the payments.
How much equity do I need to get a home equity loan?
Most lenders will want you to have at least 15% to 20% equity in your home both before and after the equity loan. So, for example, if your home is currently worth $ 300,000 and you still owe $ 270,000 to your mortgage, your equity is $ 30,000 or 10%. In this case, you probably will not qualify for a home equity loan or HELOC. If, however, you only owed $ 200,000 in your mortgage, you would have $ 100,000, or 33%, in equity and you would most likely qualify.
How can I determine how much equity I have in my home?
To determine how much equity you have in your home, you will need two numbers.
The first is how much you still owe your mortgage. This number can be found in your monthly mortgage statement or mortgage repayment schedule provided by your lender. Or, you can just call your lender and ask.
The second number is how much your home is worth right now. You can get an estimate for the ballpark by asking a local real estate agent or checking which homes have recently been sold similar to yours. For a more accurate estimate, you can hire a professional real estate appraiser.
What are the alternatives to a home equity loan or credit line?
If you are unable to obtain a home equity loan or HELOC, you may be eligible for a personal loan from a bank or other lender. These loans tend to have higher interest rates than a mortgage or HELOC, but in the case of an unsecured personal loan, you will not put your home at risk.